Questor share tip: BAE Systems looks to Saudi deal

BAE Systems is a hold after recent strong gains

Despite cuts to military budgets around the world, yesterday's update from BAE Systems gave investors more confidence in its outlook. However, the outcome of discussions with Saudi Arabia over Typhoon fighters is vital if it is meet new full–year guidance.

BAE Systems, one of the world's leading defence and aerospace groups, evolved from great British companies such as Marconi, Avro, British Aerospace and de Havilland.

BAE currently makes almost 40pc of its sales in the US, 20pc in the UK and 14pc from contracts with Saudi Arabia. Nearly 40pc of its business involves manufacturing large products such as aircraft, warships and submarines, with a slightly larger amount coming from "readiness and sustainment", which supports military kit through maintenance and fleet management activities. A further 13pc is generated in electronic systems and 6pc of sales from the rapidly growing segment of cyber–security and intelligence.

In the six months to June, sales from continuing operations rose 1pc to £2.5bn, with pre–tax profits falling to £529m from £575m. Earnings per share (EPS) from its continuing operations rose to 12.8p from 12.5p.

This modest rise in the first–half EPS figure will become "double–digit growth in underlying earnings per share" for the full year, according to yesterday's guidance.

This is up from guidance issued in May which said that EPS would show "modest growth". This also now includes any expected fallout for US budget cuts, something that reassured analysts, who have been concerned about a plunge in US sales.

The City took this increase in guidance as a hint that pricing talks with Saudi Arabia over the Typhoon sales is at an advanced stage and we will get a deal on pricing in the second half of the year.

BAE and the oil–rich Middle Eastern nation signed a deal called the "Salam" programme in 2007 to supply 72 Eurofighter Typhoon jets. But there have been delays due to issues with the cost.

The group continues to look to develop new markets outside the US, it is managing costs and it started a £1bn, three–year share buy–back programme in February this year.

The shares plunged during the financial crisis, but have recovered strongly over the past year. Despite this, they are still yielding a prospective 4.5pc, rising to 4.6pc in 2014. Investors who bought the shares last year when they were sitting at about 300p would have locked in a prospective yield of 6.8pc.

Yesterday's interim dividend was increased by 3pc to 8p a share and it will be paid on December 2. It is covered 2.2 times by earnings, ahead of the 2 times cover the group likes to maintain.

The shares are now trading on a 2013 earnings multiple of 10.7 times, but this does edge up in 2014 to 10.9, implying a slight earnings dip. But yesterday's update was supportive and Questor keeps a hold rating.